We’re still seeing a steady decline in inflation, but as recent data has proven, the trend is not smooth nor consistent. Although core PCE prices jumped 0.6 percent month-on-month, overall inflation in both Canada and the U.S. is down to nearly 6 percent and trending lower. The bad news is, the rest of the world is still playing catch up. The E.U., for instance, is only beginning to see a reversal, while Australia, New Zealand and Mexico are still in elevated territory with barely a hint of slowing. I’ve said it before, but I’ll say it again: inflation is still a global phenomenon, folks, and markets will only be sure it’s gone when we see steady downward progress across all markets. We’re just not there yet.
That said, global supply chain pressures have indeed decreased, adding further to the theory that - all else equal - inflation pressures should continue to decline, even if the declines are uneven. While we aren’t out of the woods yet, supply chains are in a healthier state than they were before. According to the Federal Reserve Bank of New York, the largest contributing factors to reduced supply chain pressures were declines in Korea delivery times, Chinese delivery times (as the country opens back up from covid), and reduced Euro area backlogs. As long as these pressures ease further, all else equal, this will help curb inflation pressures further.
Meanwhile, the yield curve remains inverted, but a careful look shows that long-dated yields are beginning to rise and catch up. Remember that an inverted yield curve suggests the market is pricing in a recession soon. If we start to see longer-dated yields rise higher, as historically has been the pattern, this will be a positive sign that recessions risks have receded. We still are at least a few weeks away from this reality, however, even if the economic data prints well. So stay tuned.
Despite this, bond markets are understandably hesitant to reduce risks from their forecast. We see 10-year yields in most countries now still barely budging across the board, from North and South America to Europe to Asia. Despite declining inflation, the bond markets seem to be debating whether tightening policy actions around the world will actually work and, if so, by how much. The IMF seems to think avoiding a recession is possible. But when will we know for sure? More data is needed.
Meanwhile, commodities also show conflicting signals. Most commodities such as oil and natural gas are at all-time lows for the past year, suggesting these markets are still pricing in a recession. But certain markets sensitive to Chinese demand, such as iron ore and copper, are actually growing as China’s economy reopens from covid. Expect these two forces to collide in the coming months.
American readers will wonder why crude oil is at its annual low while gas prices are hovering near $4 / gal in some states, particularly the Rocky Mountain states. The reason has to do with this winter’s continuous streak of frozen temperatures which has damaged refinery equipment and knocked out 17 percent of the region’s refinery capacity. Unseasonably cold temperatures have caused U.S. refineries to operate at 86 percent of capacity. So even though oil prices are at rock bottom, we’re still paying more at the pump.
Meanwhile, equity markets around the world seem to broadly be more optimistic. Daily fluctuations notwithstanding, markets have gained considerable ground since their lows late last year. The U.S. and Japan are still lagging behind Germany and Australia, however, and we still have a ways to go before making up all of our lost ground. But equity market free-fall that characterized 2022 has been stopped for now. That alone is worth celebrating.
Beyond inflation, there are still growing risks in other areas that are hitting markets, including:
a possible U.S. default expected to occur sometime between July and September. That is, if the U.S. Congress fails to raise the debt limit, which could send markets tumbling. Again, this is not the expected outcome, because neither U.S. party wants to look like they are the cause of what would be a literal global financial crisis. But make no mistake, if America’s Democrat and Republican parties prove so dysfunctional as to essentially agree on defaulting on America’s debt, the results would be a global market catastrophe.
growing tensions betweens NATO vs. the China - Russia axis. The global geopolitical environment seems to worsen by the day. Despite horrific losses in manpower, Russia seems to only want to amp up its war in Ukraine. Meanwhile, China dislikes Russia’s recklessness but hates what it sees as NATO “imperialism” even more. China’s 12-point peace plan summary came out today but offered nothing in terms of substantial bargaining points for Ukraine, as expected. And if it is proven China is supplying weapons to Russia, then we fully can expect global war tensions to ratchet up.
All in, while markets have broadly improved since late last year, we should not expect this trend to be in one direction. Inflation risks still linger, and geopolitical risks are increasing.
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